Essential Guide to Digital Asset Custody: How to Pick the Optimal Digital Asset Custody Provider

As increasing numbers of TradFi organizations are engaging in crypto-related transactions — something that used to be the sole purview of crypto service providers — there’s a growing need to safely store digital assets. So, need also increases to appropriately evaluate digital asset custody services.

Digital asset custody providers play a linchpin role in protecting these assets for the investor-owner and can help to allow participants to engage in the ecosystem with a sense of confidence. Although digital asset custody can resemble that of TradFi, there are notable differences and a position could be taken that the quality of digital asset custody provided is even more crucial — and that is, at least in part, because of the keys involved.

Digital Asset Custody: Cryptographic Keys

Digital assets, as the name implies, are not physical objects. Instead, they’re created through a process called cryptography and reside on blockchain networks. The blockchain is used to record digital transactions, and this is generally the only place where a record of these transactions will be found.

To prove ownership of the virtual assets, owners are provided with keys — a randomly generated series of numbers and letters that resembles a password. So, digital asset custody service providers aren’t actually storing the assets themselves. Instead, they’re safeguarding the investors’ keys. If these keys get lost or stolen, then the digital assets could be irretrievable. So, digital asset custody providers store and protect these keys to safeguard the assets.

Digital Asset Custody: Digital Wallets

Keys are used to access wallets containing the digital assets. At a minimum, a wallet would contain private keys and public keys. Here are definitions of the two types and their purposes.

• Private keys prove the ownership of the digital assets and are used when an owner wants to access their assets; for example,the owner wants to sell cryptocurrency or transfer the ownership to someone else. For these transactions to occur, the owner uses the private key to “sign” it. This key should never be shared with anyone else because that would allow them to transfer the assets into another wallet. Typically, these randomly generated sets of numbers are quite large, making them quite difficult for someone else to guess at their structure.

• Public keys create an address to allow deposits to be made to the wallet, so these addresses can be publicly shared. These keys also contain an extremely long series of numbers.

Multiple types of digital wallets exist with differing levels of security and access, and digital asset custody providers can use one or more of these types.

Hot Wallets

Hot wallets are always connected to the internet with transactions created and recorded in automated ways; private keys are stored online. These wallets allow users to quickly transfer assets, which is a plus. However, the always-connected approach means that the assets are more vulnerable to theft when security is compromised. Check to see if your digital asset custody provider of choice offers this type of wallet.

Cold Wallets

Private keys are stored offline with human involvement needed to sign each transaction. Cold wallets optimize security because hackers can’t access offline information. It can take a day or two to transfer funds, though, which isn’t workable for rapid asset transfer. Also check to see if your digital asset custody provider of choice offers these.

Warm Wallets

These wallets combine features of both hot and cold wallets. Keys are online and transactions can be automatically generated, but humans must sign the transaction and forward it to the blockchain.

Multisig Wallets

Digital asset custody providers may take a multisignature (multisig) approach to enhance security. This requires more than one private key to authorize a transaction; they can be located in different systems so that, even if one system experiences a security problem, theft cannot proceed.

This also allows organizations to require signatures from multiple team members for a transaction to occur. The organization can set the number of authorized keys (“N”) and the number of signers required to authorize a transaction (“M”). Once the M-of-N is set, however, it cannot be changed; instead, a new wallet will need to be created. Not all digital asset custody providers offer this type of security, so be sure to investigate the provider you’re considering if you’d like to have this kind of protection.

Digital Asset Custody: Deployment Matters

Once you’ve got your digital assets into wallets of choice, you’ll want to ensure that your digital asset custody service offers deployment services in ways that dovetail with your needs. First, consider how you’ll want to deploy your assets. This may include trading, borrowing, lending, staking, settlement, and more, which can include DeFi and other exchange integrations.

Questions to ask yourself when consider digital asset custody options can include these:

• Can you trade, settle, and stake from a cold storage option?

• Will you receive quality price executions on your trades?

• How does your digital asset custody provider select validators?

• What fees do the digital asset custody provider charge? Is the fee structure reasonable?

Digital Asset Custody: When Seeking a Digital Asset Custody Service Provider

If comparing options in digital asset custody providers, it can make sense to look for a custodian that offers hot and cold wallets that will hold most of the types of tokens you want to have and maintains insurance to protect you from theft, misuse, or loss. What else to look for: a digital asset custody provider with SOC1 and SOC2 accreditations with human processes to complement their technology.

Digital Asset Custody: Summary of the Benefits of Using a Digital Asset Custody Provider

A digital asset custody provider can help to streamline and simplify the process for the investors using them. The investors don’t, for example, need to track their own private keys — a benefit that becomes increasingly more important as the investors’ portfolios grow in size and complexity. Digital asset custody providers can also enhance the security of a wallet and asset portfolio, protecting them from threat actors and other types of misuse. Plus, when a digital asset custody provider offers insurance against theft, misuse, and loss — like BitGo does — then the risk is greatly reduced for the investor.

When using BitGo as your digital asset custody provider, your institution can benefit from enhanced efficiencies, allowing you to nimbly adapt to your business needs and scale as needed.

Digital Asset Custody: Meeting the Gold Standard

BitGo meets the gold standard for institutional investors as keys are guarded in bank-grade vaults with redundant security procedures. The keys are stored on a machine that doesn’t touch the internet with financial assets insured by $250 million against theft or loss of keys. If you’re looking for a custody provider for institutional investors, please contact BitGo.

Digital Asset Custody FAQs

Why is digital asset custody important?

When using the right custodian for your financial assets, your institution can:

• safely and securely store your tokens and coins

• deploy assets as desired

• enjoy a streamlined and simplified process for you and your financial assets

• proceed with confidence in your transactions

• provide additional services like insurance against loss, misuse, and theft of your financial assets

If your institution is looking for a digital asset custodian, then we encourage you to reach out to BitGo to talk to our experts.

What are the types of digital asset custody?

First, here’s a quick definition of a digital asset custody service: the provider offers safe and secure custody of digital tokens and coins.

At a high level, there are two types of custody for digital assets: self custody and custody services. People sometimes choose self storage because they don’t want to be dependent on someone else, such as a custody provider, to manage their assets, and they may want greater access to them. Plus, they may not feel confident in knowing how to choose the right custodian. Challenges with self custody, though, exist. If, for example, funds are lost through accident, misuse, or theft, they can be gone permanently. Choosing the wrong custody provider could lead to the same type of situation.

There are also regulated types and unregulated types of digital asset custody. Custodians can become regulated after undergoing a rigorous process, and they must continue to meet standards and undergo audits. Plenty of custody providers for digital assets don’t go through all of this, and so they’re unregulated custodians that don’t have a fiduciary duty towards you as a client like a regulated custodian would.

Here’s another way to look at the concept of digital asset custody. A qualified custodian is one that’s regulated in the United States through the Investment Advisers Act of 1940, and they must be a specific type of entity such as a state trust.

How can I talk to BitGo about becoming our business’s digital asset custody provider?

Simply reach out to BitGo today to talk to our experts!